Will Shale Oil Innovation And Productivity Offset Any OPEC Production Cut?

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Includes: DVN, EOG, HES, PXD, WLL
by: Gary Bourgeault

Summary

Improvements in technology and methodology not being priced into an OPEC production cut.

The factor that hasn't existed before.

Increasing number of rigs and completed wells are where it plays a bigger role than in the past.

Shale production in the months ahead could easily exceed expectations - offsetting any OPEC cut.

source: Stock Photo

With all the media noise surrounding the announcement there may be a production cut if OPEC members and Russia specifically, can come to an agreement on the terms of a deal. Russia is included because OPEC is trying to limit the loss of market share if it does end up shrinking output.

The major question if an agreement is made and adhered to is how quickly U.S. shale producers ramp up production, and the increased productivity and efficiencies of the top producers have on the level of supply, and the resultant profits.

The shale industry has improved technology and methodology to the point the wells being completed at this time are significantly outperforming past wells; not only increasing the amount of oil, but doing so at lower costs than in the past.

A lot of old school analysts and pundits are acting like a production cut from OPEC will have the same impact and importance it had in the past, but the fact is this is the first time it has attempted to "manage" the market since the U.S. shale industry has launched the U.S. into being one of the top oil producers in the world, and in the near future, it will become No. 1.

Why production cut will backfire

My main reason for understanding the improvement in efficiencies and productivity by the quality U.S. shale producers isn't being priced in by the market, is the commentary and news stories reporting the proposed production cuts from OPEC and Russia, as having the same effect they've had in the past, if the deal was even moderately adhered to.

The problem with that narrative is the U.S. is now the third-largest oil producer in the world, and as already mentioned, will soon jump to No. 1.

It's not only the amount of oil it is able to bring to market, but how quickly it can do so from the drilled but uncompleted (NYSE:DUC) wells ready to quickly be completed under the conditions the shale producers are looking for.

The rise in oil rigs and wells are indicative of the fact the better shale producers consider this that period of time to boost production. OPEC will be playing into their hands if it comes to an agreement, giving shale producers the opportunity to take market share away from OPEC producers.

What is at question is whether or not OPEC has slowed down the U.S. shale industry enough to give it time to temporarily support oil prices with lower output.

Innovative improvements are increasing productivity and efficiency

On the methodology side of the shale business, here are some of the things top shale producers are doing to increase productivity:

Pioneer Natural Resources (NYSE:PXD) is increasing the length of stages in its wells, Hess Corp. (NYSE:HES) is raising the total number of stages, EOG Resources (NYSE:EOG) is drilling in extremely tight windows, while Whiting Petroleum Corp. (NYSE:WLL) and Devon Energy Corp. (NYSE:DVN) have loaded up more sand in their wells, ...."

As more wells are completed, this will add an unknown amount of supply to the market that exceeded past performances. Some in the industry look at these new methods or techniques as having the potential to increase production in a range of 5 to 50 percent. This doesn't include the targeting of specific oil deposits with much higher output potential, which new technology now allows these companies to do.

It's not that the methods above are new, it's that they're being employed at much higher levels than in the past in response to the price of oil expected to remain subdued for longer than believed in the recent past.

To give an example of how cutting stage lengths has helped Pioneer and Hess, Pioneer cut theirs by 60 percent, while adding one cluster at a time, which increased the number of barrels per foot from 30 to 36 in all the wells it has. That represents a increase quarter-over-quarter early in 2016 to 2,2000 barrels per day at its Permian wells. That's up by over 15 percent.

Hess did even better as it increased its stage counts by close to 40 percent to 50 percent, generating a production increase of over 20 percent at essentially the same costs as before. These two shale producers and others have been able to do this while lowering or maintaining costs. It's only going to get better.

New rigs being added recently will be able to produce faster at more productive locations, providing a supply challenge to OPEC and Russia, no matter what decision is made in November.

Devon and Whiting have completed their wells by using what is basically a high concentration of sand. Initial production levels are up as high as 50 percent above former levels.

Tech improvements with fracking and modeling

On the tech side of the business, a couple of improvements have been in regard to fracking and modeling.

Concerning fracking, the more valuable improvements have been with geomechanical interactions. What this refers to is when the process of fracking results in a simultaneous fracture causing nearby cracks to close up. This changes their trajectories resulting in them being unparallel to one another. This effect is predominant amount fractures that are close to each other.

Improving what is called hydrofracking is the result of the development of unique software which is able to give a glimpse of what the characteristics of the fractures will be. The software does that by taking into account the data fed into it and analyzing it as it takes into account the type of fracking fluid used and the rock formation being worked.

Another valuable tool that has improved the productivity of wells is the development of computer simulations, allowing engineers to constrain parameters more accurately and implement the best strategy to achieve the more profitable results. Service companies like Halliburton and Schlumberger use computer modeling to provide the best avenue to take when fracking.

Conclusion

There are a number of other improvements that could be cited for the U.S. shale industry, but these are shown to underscore the increase in productivity and costs that have made the U.S. shale industry so difficult to compete against.

For these reasons I've always viewed the idea of a freeze or cut from OPEC as irrelevant. It will temporarily give oil a boost, but I see no way it can be sustainable. The reason, again, is shale supply at these levels didn't exist in the past, and where it did, it wasn't very competitive on the cost side to make it a threat to OPEC. That has now quickly changed, and if OPEC does implement a legitimate production cut, it'll be a very short period of time before hundreds if not thousands of drilled but uncompleted wells in the U.S. are completed.

Those wells are far more competitive than past wells, and even at about $45 per barrel the better shale producers can generate pre-tax profits. At about $50 per barrel, they will not only boost production, but others that are close to profitability at $45 per barrel will join the parade of U.S. producers boosting crude output.

What all this means is much of the oil market is analyzing the assumed OPEC production cut from a past industry model that no longer exists. Cutting production with a new competitor that can quickly increase production by completing wells is a huge game changer. That type of competition has never existed at a time when OPEC was considering using its former muscle to manage the market. The truth is OPEC can no longer manage the market as it has in the past, with the exception it can keep supply levels high and keep downward pressure on the price of oil as long as an increase in demand doesn't catch up with it.

This is also a unique period of time for the industry, as there is this one time window open for a few months that will possibly allow OPEC to have an impact on all of the oil price ranges because of the time it'll take for shale producers to bring enough supply to the market to offset any cuts if they're made by OPEC.

Investors looking for some quick gains can make some money under these temporal conditions, but further out it will be how much oil U.S. shale producers bring to the market that will dictate the price of oil.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.